Help Is on the Way for Student Loans

June 23, 2009

Column By DAVID McPHERSON

Relief is just around the corner for the many young Americans who struggle under the weight of student-loan debt.

On July 1, a new federal program aimed at easing the monthly burden on college graduates making hefty loan payments on modest salaries. The new Income Based Repayment plan is supposed to cap monthly payments at an amount considered affordable based on income and family size.

For most eligible borrowers, payments will amount to less than 10 percent of their income, according to the Project on Student Debt, a nonprofit group that operates a Web site explaining the program.

Income Based Repayment also will forgive student-loan debt that remains after 25 years of payments. And graduates who enter public service careers may qualify for loan forgiveness after 10 years.

This new program is in addition to the Income Contingent Repayment and economic hardship deferments plans already available to student-loan borrowers.

The Income Based Repayment option applies to Stafford, Grad PLUS or consolidation loans made under either the Direct Loan or Federal Family Education Loan programs. It does not apply to loans currently in default, parent PLUS loans, consolidation loans that repaid a parent PLUS loan or private student loans.

The eligible loans can be new ones just entering repayment or existing loans that have been in repayment for years. They could have been used to pay for any type of education, including undergraduate, graduate, professional and job training.

Borrowers looking to take advantage of this program will need to contact their lender to apply. Lenders will determine eligibility. It remains to be seen how prepared these lenders will be to handle a flood of applicants beginning next week. So patience may be needed if you're looking to take advantage of this new option.

Sallie Mae, the nation's largest student lender, has posted a worksheet to help borrowers determine their eligibility, but you will have dig through the company's Web site to find it. It's located on the "Income-based repayment" page within the "After Graduation" section of salliemae.com.

The Project on Student Debt estimates that at least 1 million student loan borrowers will be able to lower their monthly payments under the new plan.

Mandated by the College Cost Reduction Act of 2007, the Income Based Repayment program relies on a sliding scale that incorporates income, family size and state of residence.

Under this formula, monthly payments under a standard 10-year repayment plan are capped at 15 percent of the portion of family income that exceeds 150 percent of the federal poverty level.

For example, for a single person with no dependents and an adjusted gross income of $30,000, the maximum monthly payment would be $172.

Assuming this person had borrowed $25,000 at 6.8 percent interest, that $172 monthly payment would mean paying $116 less each month than the $288 that would have been due under a standard, 10-year repayment plan.

The key benefit of Income Based Repayment is that it can make your payments more manageable early in your career when your earn less. However, these lower monthly payments may result in longer repayment periods and additional interest costs.

If your earnings are low enough that your monthly payment does not cover the interest that accrues on your loans, then the federal government will pay the unpaid interest on subsidized Stafford loans for up to three years. (Note that this benefit does not apply to unsubsidized Stafford loans and other types of federal student loans.) Unpaid interest not covered by this federal subsidy gets added on to your overall student-loan balance.

If any loan balance remains after 25 years in Income Based Repayment, that unpaid student debt may be cancelled.

There also is an option to have student loans forgiven after 10 years for graduates who embark on careers in lower-paying public service jobs in the government or nonprofit sectors.

To qualify for this benefit, borrowers must be sure their loans are in the Direct Loan program. If not, there is a mechanism to switch to the Direct Loan program to qualify for this benefit.

To learn if you qualify for Income Based Repayment or Public Service Loan Forgiveness programs, visit the following Web sites: ibrinfo.org and StudentAid.ed.gov run by the U.S. Department of Education.

On both sites you will find calculators that will help you determine whether you might be able to ease your student-loan debt burden.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.

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